Standard Costing

Variance Analysis
 Standard Cost
Input : Output
Standard vs. Budget

Variance Analysis

Standard Cost System

Activity Analysis

Historical Data

Benchmarking

Target Costing
 Management focus time in areas where
there are problems, as identified by the fact
that there is a variance from the standard.
 Management focus time in areas where
there are problems, as identified by the fact
that there is a variance from the standard.
 STATIC BUDGET is the one prepared for one
specific level of planned activity, and that level of
planned activity does not change, no matter what
the actual activity is.

FLEXIBLE BUDGET is the one that shows

amount that is adjusted to the actual level of activity
that has occurred
 STATIC BUDGET is the one prepared for one
specific level of planned activity, and that level of
planned activity does not change, no matter what
the actual activity is.

FLEXIBLE BUDGET is the one that shows

amount that is adjusted to the actual level of activity
that has occurred
 STATIC BUDGET is the one prepared for one
specific level of planned activity, and that level of
planned activity does not change, no matter what
the actual activity is.

FLEXIBLE BUDGET is the one that shows

amount that is adjusted to the actual level of activity
that has occurred
 Characteristics of Flexible Budgets
Hmm! Comparing
static planning budgets
Planning budgets with actual costs
are prepared for is like comparing
a single, planned apples and oranges.
level of activity.
Performance
evaluation is difficult
when actual activity
differs from the
planned level of
activity.
Characteristics of Flexible Budgets
May be prepared for any activity
level in the relevant range.

Show costs that should have been

incurred at the actual level of
activity, enabling “apples to apples”
cost comparisons.

Help managers control costs.

Improve performance evaluation.

Let’s look at Larry’s Lawn Service.
Deficiencies of the Static Planning Budget

Larry’s Lawn Service provides lawn care in a planned

community where all lawns are approximately the same size.
At the end of May, Larry prepared his June budget based on
mowing 500 lawns. Since all of the lawns are similar in size,
Larry felt that the number of lawns mowed in a month would
be the best way to measure overall activity for his business.

Larry’s Budget
 Deficiencies of the Static Planning
Budget
Larry’s Planning Budget

Mixed
Costs
Variable
Costs
Fixed
Costs
 Deficiencies of the Static Planning
Budget
Larry’s Actual Results Compared with the Planning Budget
 Deficiencies of the Static Planning
Budget
Larry’s Actual Results Compared with the Planning Budget
 Deficiencies of the Static Planning
Budget
Larry’s Actual Results Compared with the Planning Budget

Since these variances are unfavorable, has

Larry done a poor job controlling costs?

Since these variances are favorable, has

Larry done a good job controlling costs?
 Deficiencies of the Static Planning
Budget
▪ The relevant question is . . .
“How much of the cost variances are due to
higher activity and how much are due to cost
control?”
▪ To answer the question,
we must
the budget to the
actual level of activity.
 How a Flexible Budget Works

To a budget, we need to know that:

– Total variable costs change
in direct proportion to
changes in activity.
– Total fixed costs remain
unchanged within the
relevant range. Fixed
Preparing a Flexible Budget
Larry’s Flexible Budget
Revenue and Spending Variances
Actual revenue Flexible budget revenue

The difference is a revenue variance.

Actual cost Flexible budget cost

The difference is a spending variance.

 Revenue and Spending Variances
Larry’s Flexible Budget Compared with the Actual Results
Revenue Variance
$1,750 favorable
 Revenue and Spending Variances
Larry’s Flexible Budget Compared with the Actual Results
Spending Variances
$1,950 unfavorable total
 Standard Costs
Standards are benchmarks or “norms” for
measuring performance. In managerial accounting,
two types of standards are commonly used.

Quantity standards Price standards

specify how much of an specify how much
input should be used to should be paid for
make a product or each unit of the
provide a service. input.

Examples: Firestone, Sears, McDonald’s, hospitals,

construction, and manufacturing companies.
Setting Direct Materials Standards
Standard Quantity Standard Price
per Unit per Unit

Summarized in Final, delivered

a Bill of Materials cost of materials,
net of discounts
Setting Direct Labor Standards
Standard Hours Standard Rate
per Unit per Hour

Use time and Often a single

motion studies for rate is used that reflects
each labor operation the mix of wages earned
Setting Variable Manufacturing Overhead Standards
Quantity Price
Standard Standard

The quantity is The rate is the

the activity in the variable portion of the
allocation base for predetermined overhead
predetermined overhead. rate.
 The Standard Cost Card
A standard cost card for one unit of
product might look like this:
A B AxB
Standard Standard Standard
Quantity Price Cost
Inputs or Hours or Rate per Unit
Direct materials 3.0 lbs. $ 4.00 per lb. $ 12.00
Direct labor 2.5 hours 14.00 per hour 35.00
Variable mfg. overhead 2.5 hours 3.00 per hour 7.50
Total standard unit cost $ 54.50
 Using Standards in Flexible Budgets

Standard costs per unit for direct materials, direct labor,

and variable manufacturing overhead can be used to
compute activity and spending variances.

Spending variances become more

useful by breaking them down into
price and quantity variances.
A General Model for Variance Analysis

Variance Analysis

Price Variance Quantity Variance

Difference between Difference between

actual price and actual quantity and
standard price standard quantity
 Price and Quantity Standards
Price and quantity standards are determined
separately for two reasons:

1. Different managers are usually responsible for buying and

using inputs. For example, the purchasing manager is
responsible for raw material purchase prices and the
production manager is responsible for the quantity of raw
material used.

2. The buying and using activities occur at different times. Raw

material purchases may be held in inventory for a period of
time before being used in production.
 A General Model for Variance Analysis

Variance Analysis

Price Variance Quantity Variance

Materials price variance Materials quantity variance

Labor rate variance Labor efficiency variance
VOH rate variance VOH efficiency variance
 Responsibility for Materials Variances

I am not responsible for

this unfavorable materials
quantity variance.
You purchased cheap
material, so my people
had to use more of it.

Production Manager Purchasing Manager

Responsibility for Materials Variances
Your poor scheduling
sometimes requires me to
rush order materials at a
higher price, causing
unfavorable price variances.

Production Manager Purchasing Manager

 Responsibility for Labor Variances
Production managers are Mix of skill levels
usually held accountable assigned to work tasks.
for labor variances
because they can
Level of employee
influence the:
motivation.

Quality of production
supervision.

Quality of training
provided to employees.
Production Manager
Responsibility for Labor Variances
I think it took more time
to process the
I am not responsible for materials because the
the unfavorable labor Maintenance
efficiency variance! Department has poorly
maintained your
You purchased cheap equipment.
material, so it took more
time to process it.
Materials Variances
Materials Variances
Labor Variances
variance -
 Overhead Variances

ACTUAL BAAH BASH APPLIED

Actual FOH Budget Allowed Budget Allowed Standard FOH
Actual VOH Based on Actual Based on Standard VOH
Hours Standard Hours

Formulas

Actual FOH FOH Rate x NC FOH Rate x NC FOH Rate x SH

Actual VOH VOH Rate x AH VOH Rate x SH VOH Rate x SH
 One (1) – Way

ACTUAL BAAH BASH APPLIED

Actual FOH FOH Rate x NC FOH Rate x NC FOH Rate x SH
Actual VOH VOH Rate x AH VOH Rate x SH VOH Rate x SH

---------------------------------------------------- Total OH Variance ----------------------------------------------------

 One (1) – Way

ACTUAL BAAH BASH APPLIED

Actual FOH FOH Rate x NC FOH Rate x NC FOH Rate x SH
Actual VOH VOH Rate x AH VOH Rate x SH VOH Rate x SH

---------------------------------------------------- Total OH Variance ----------------------------------------------------

 Two (2) Way

ACTUAL BAAH BASH APPLIED

Actual FOH FOH Rate x NC FOH Rate x NC FOH Rate x SH
Actual VOH VOH Rate x AH VOH Rate x SH VOH Rate x SH

---------------------------------------------------- Total OH Variance ----------------------------------------------------

 Two (2) Way

ACTUAL BAAH BASH APPLIED

Actual FOH FOH Rate x NC FOH Rate x NC FOH Rate x SH
Actual VOH VOH Rate x AH VOH Rate x SH VOH Rate x SH

------------------ Controllable Variance ---------------- ------- Non Cont. Variance ------

---------------------------------------------------- Total OH Variance ----------------------------------------------------

 Two (2) Way

ACTUAL BAAH BASH APPLIED

Actual FOH FOH Rate x NC FOH Rate x NC FOH Rate x SH
Actual VOH VOH Rate x AH VOH Rate x SH VOH Rate x SH

--------------------- Budget Variance ----------------------- -------- Volume Variance -------

---------------------------------------------------- Total OH Variance ----------------------------------------------------

 Three (3) – Way

ACTUAL BAAH BASH APPLIED

Actual FOH FOH Rate x NC FOH Rate x NC FOH Rate x SH
Actual VOH VOH Rate x AH VOH Rate x SH VOH Rate x SH

--------------------- Budget Variance ----------------------- -------- Volume Variance -------

---------------------------------------------------- Total OH Variance ----------------------------------------------------

 Three (3) – Way

ACTUAL BAAH BASH APPLIED

Actual FOH FOH Rate x NC FOH Rate x NC FOH Rate x SH
Actual VOH VOH Rate x AH VOH Rate x SH VOH Rate x SH

-- Spending Variance --

--------------------- Budget Variance ----------------------- -------- Volume Variance -------

---------------------------------------------------- Total OH Variance ----------------------------------------------------

 Three (3) – Way

ACTUAL BAAH BASH APPLIED

Actual FOH FOH Rate x NC FOH Rate x NC FOH Rate x SH
Actual VOH VOH Rate x AH VOH Rate x SH VOH Rate x SH

-- Spending Variance -- --- Efficiency Variance ---

--------------------- Budget Variance ----------------------- -------- Volume Variance -------

---------------------------------------------------- Total OH Variance ----------------------------------------------------

 Three (3) – Way

ACTUAL BAAH BASH APPLIED

Actual FOH FOH Rate x NC FOH Rate x NC FOH Rate x SH
Actual VOH VOH Rate x AH VOH Rate x SH VOH Rate x SH

-- Spending Variance -- --- Efficiency Variance --- ----- Volume Variance ----

--------------------- Budget Variance ----------------------- -------- Volume Variance -------

---------------------------------------------------- Total OH Variance ----------------------------------------------------

 Four (4) – Way
--- Fixed SV ---
--- Variable EV --- ----- Fixed VV ----
--- Variable SV ---

ACTUAL BAAH BASH APPLIED

Actual FOH FOH Rate x NC FOH Rate x NC FOH Rate x SH
Actual VOH VOH Rate x AH VOH Rate x SH VOH Rate x SH

-- Spending Variance -- --- Efficiency Variance --- ----- Volume Variance ----

--------------------- Budget Variance ----------------------- -------- Volume Variance -------

---------------------------------------------------- Total OH Variance ----------------------------------------------------

 Overhead Variances
--- Fixed SV ---
--- Variable EV --- ----- Fixed VV ----
--- Variable SV ---

ACTUAL BAAH BASH APPLIED

Actual FOH FOH Rate x NC FOH Rate x NC FOH Rate x SH
Actual VOH VOH Rate x AH VOH Rate x SH VOH Rate x SH

-- Spending Variance -- --- Efficiency Variance --- ----- Volume Variance ----

--------------------- Budget Variance ----------------------- -------- Volume Variance -------

---------------------------------------------------- Total OH Variance ----------------------------------------------------

Materials Price Variance Materials Yield Variance

Materials Mix Variance

Materials Price Variance Materials Yield Variance

Materials Mix Variance

Labor Rate Variance Labor Efficiency Variance

Factory Overhead Variances